Stability and Transitions in Emerging Market Policy Rules

Published By: IGIDR on eSS | Published Date: February, 01 , 2015

Conditions for stability in an open economy dynamic stochastic general equilibrium model adapted to a dualistic labor market (SOEME) are the same as for a mature economy. But the introduction of monetary policy transmission lags makes it deviate from the Taylor Principle. Under rational expectation a policy rule is unstable, but under adaptive expectations traditional stabilization gives a determinate path, with weights on the objective of less than unity. Estimation of a Taylor rule for India and optimization in the SOEME model itself, all confirm the low weights. The results imply that under rational expectations optimization is better than following a rule. If backward looking-behaviour dominates, however, a policy rule can prevent overshooting and instability. Economy-specific rigidities must inform policy design, and the appropriate design will change as the economy develops.

Author(s): Ashima Goyal | Posted on: Mar 11, 2015 | Views() | Download (409)

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